In his speech at a St. Louis Federal Reserve symposium, Fed governor Jeremy Stein pointed out the stunning growth of real estate investment trusts that buy mortgage-backed securities backed by Fannie Mae and Freddie Mac guarantees.

These agency REITs buy agency mortgage-backed securities (MBS), fund them largely in the short term repo market in what is essentially a levered carry trade, and are required to pass through at least 90 percent of the net interest to their investors as dividends. As shown in exhibit 7, they have grown rapidly in the past few years, from $152 billion at year-end 2010 to $398 billion at the end of the third quarter of 2012.

One interesting aspect of this business model is that its economic viability is sensitive to conditions in both the MBS market and the repo market. If MBS yields decline, or the repo rate rises, the ability of mortgage REITs to generate current income based on the spread between the two is correspondingly reduced.

Here's the chart from exhibit 7:

Does that look like the behavior of a healthy asset class or one that is experiencing a massive bubble?